Can Euro stocks close the return gap?

With bad news priced in, any good news could boost valuations

European equity gains have outpaced the U.S. to start 2025. We had said Europe’s stocks needed a catalyst to turn around poor sentiment. We now see several that – if they materialize – could boost cheap valuations, so we close our underweight on Europe’s stocks. Yet we still expect the U.S. to reclaim leadership this year and stay overweight U.S. stocks as corporate earnings strength and the artificial intelligence (AI) theme broaden out. We turn more underweight long-term U.S. Treasuries.

U.S. equities have long outperformed their global peers. Some pin that on tech’s greater share in its market, bigger fiscal spend in recent years, and energy independence, but we would attribute it more to deeper capital markets and relative deregulation that promote risk-taking.

We think the U.S. can keep its edge, even if the S&P 500 has lagged so far this year. Yet we believe Europe can close some of the return gap. With a lot of bad news priced into European equities, even prospects of good news could help them push higher. One example: Possible de-escalation in the Ukraine war. Reduced reliance on Russian gas brought European energy prices down from 2022’s highs. See the chart below. A form of peace agreement could lower energy prices further, boosting European growth and lowering inflation. This is just one of several catalysts we think could broaden U.S. equity strength to Europe.

We eye other catalysts for European equities as well. We expect more defense spending as the U.S. has stated Europe is no longer a primary security priority. The EU now has an air of urgency that typically spurs action. In Germany, the weekend’s election result could herald fiscal loosening – though it’s a long and uncertain road there.

Still sluggish euro area growth and easing inflation gives the European Central Bank room to cut rates more this year, we think. So, we go neutral Europe’s stocks and still favor European financials – a preference that also served us well last year. Yet Europe still faces multiple structural issues, from lagging competitiveness to potential U.S. tariffs – justifying some of Europe’s hefty valuation discount, we think.

Positive on the U.S.

Our assessment of the U.S. is unchanged: We expect mega-cap tech and other AI-linked stocks to keep driving U.S. equity returns, especially as AI adoption grows. But we also see signs of earnings strength broadening beyond tech.

Analysts now expect tech to deliver 18% earnings growth this year versus 11% for the broader index, LSEG data show – a smaller gap vs. 2024. We think risk assets could also weather the higher growth and higher inflation mix we see as increasingly possible. New tariffs and U.S. policy shifts aimed at boosting growth, like deregulation, carry inflationary potential.

Markets have embraced our higher-for-longer rate view, yet we still see term premium rising more than currently priced as investors demand more return for the risk of holding long-term bonds – even if the administration’s focus on long-term yields and talks of pausing quantitative tightening could delay some of the rise for now. We go further underweight long-term U.S. Treasuries as a result.

In China, apparent efficiency gains by AI startup DeepSeek have driven a surge in China’s tech sector. President Xi Jinping’s recent meeting with private sector business leaders could signal a more supportive regulatory backdrop, yet the broader environment of U.S.-China technology competition may present challenges. We evolve our tactical overweight to Chinese equities as tech excitement could keep driving returns, potentially reducing the odds of much-anticipated government stimulus. Over the longer term, we are more wary given structural challenges to China’s growth and tariff risks.

Our bottom line

We stay overweight U.S. equities, even with their softer start to 2025. Yet we think their lead over global peers could narrow this year. We upgrade European stocks to neutral while going further underweight long-dated U.S. Treasuries.

Wei Li, Managing Director, is the Global Chief Investment Strategist at BlackRock Investment Institute at BlackRock Inc.

Jean Boivin is Managing Director, Head of the BlackRock Investment Institute at BlackRock Inc.

Vivek Paul, Global Head of Portfolio Research – BlackRock Investment Institute, and Roelof Salomons, Chief Investment Strategist for the Netherlands – BlackRock Investment Institute, contributed to this article.

Disclaimer

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